If you are approaching or exceeding the federal estate tax exemption threshold or your state estate tax threshold and desire to decrease your estate tax liability, you may consider one or more tried and true strategies. While they differ in scope, each of these strategies at its core does one of two things:
- Reducing the value of your Gross Estate
- Increasing the magnitude of the deductions from your Gross Estate to your Taxable Estate
Reducing the value of your gross estate
You can reduce the value of your gross estate by reducing the assets that you own or control at the time of your death. In many cases, you can do this while benefitting the same people or interests to whom you plan to give under your estate plan without incurring additional tax.
#1 Lifetime gifts to children and grandchildren:
Gifts to individuals below the gift tax threshold are not taxed. In 2023, you can give up to $17,000 to a single individual ($34,000 if you are married and filing a joint return) without paying tax.
#2 Irrevocable life insurance trusts:
Life insurance gives funds to your loved ones in the event of your passing. You can set up an irrevocable life insurance trust by creating a trust, making the trust the beneficiary of your life insurance policy, and transferring ownership of that trust to someone else. By transferring over your life insurance policy, your death benefits wouldn’t be part of your estate. Keep in mind that if you die within 3 years of completing the transfer, the life insurance proceeds would still be considered part of your Taxable Estate.
#3 Paying directly for tuition or medical expenses:
Tuition and medical expense payments are not subject to the annual gift tax exclusion. By paying these expenses directly on behalf of a loved one, you can increase your loved one’s wealth by allowing them to forgo paying this expense themselves.
If your loved ones do not yet have tuition expense, you can save against future expected tuition expense by contributing to a 529 plan. Contributions are treated as gifts and therefore count against the gift exclusion threshold. However, you can make an election to "super fund" the 529 plan by making a one-time contribution of up to $85,000 and spreading that contribution over 5 years (meaning, you will be unable to contribute additional money in the next 4 years without tripping the gift tax threshold).
#4 Gift to a political organization for its use:
Donations to political organizations are not subject to the annual gift tax exclusion.
#5 Creating a private annuity:
In a typical private annuity transaction, you transfer property to your children or other beneficiaries in exchange for their unsecured promise to make annual payments, the annuity, for the rest of your life. As long as the present value of the annuity is approximately equal to the property’s fair market value, there’s no gift tax on the transaction. The property’s value is removed from your estate, and any further appreciation of value accrues to the new individual or individuals possessing the ownership claim. Although you will need to pay capital gains taxes on the income received, this capital gains tax is typically a much lower rate than the estate tax rate.
#6 Establish a family limited partnership:
If you own a large business or property assets that you want your children to own after you pass, you can set up a family limited partnership. As the general partner, you’ll still be able to control the dealings of the partnership during your life. But your partners, who might be your children or another relative, will have a stake in your company or own a portion of your assets, thereby decreasing the size of your estate.
#7 Special use real estate valuation:
The value of real estate in your Gross Estate is by default the fair market value of the real estate. However, depending on the nature of the property you may be able to qualify to use a special-use real estate valuation instead of the default fair market value. For example, if you own and operate a family farm that has a high fair market value due to its proximity to other high value commercial or residential property, you may be able to claim a lower valuation due to its special use as a farm.
#8 Qualified Personal Residence Trust:
A Qualified Personal Residence Trust is a type of irrevocable trust to which an individual transfers ownership of his or her residence while retaining the right to occupy the premises for the specified term. If the individual survives the term, ownership of the residence transfers to the benefit of the beneficiaries under the trust. Although the transfer is subject to gift tax, the value of the transfer is the value of the real estate at the start of the trust term, which may be lower than the current fair market value if the asset has appreciated, less the value of the gifter’s retained interest.
Increasing the deductions
#9 Marital transfers:
If you are married, you can use unlimited marital transfer deduction to transfer most or all your estate to your spouse tax-free and make what is known as a portability election to so that your spouse can use double the federal estate tax exemption (your exemption + your spouse’s exemption, or about $22 million in 2022). If you’re in a committed relationship but not married, consider tying the knot as a way to minimize estate taxes
#10 Charitable transfers:
You can deduct gifts to qualified charitable organizations from your Gross Estate upon your death, and these charitable gifts will not be taxed. You might even consider going a step further and creating a charitable trust, such as a Charitable Remainder Trust, during your life. This gives you a charitable income tax deduction when the trust is funded, you can continue to make money off the asset during your life, and it gives your estate a charitable estate tax deduction when you die.
Bonus: Avoiding State Estate Tax
The 10 strategies for minimizing estate tax discussed in this article focus on ways to either reduce the value of your Gross Estate or take advantage of permissible deductions from the Gross Estate in arriving at the Taxable Estate.
If you live in one of the 17 states that has a state estate and/or inheritance tax, there is an arguably even more straightforward way to avoid paying state estate taxes. Move! You may even find by moving that you doubly save by saving not only on estate tax but also on lower state income and property tax rates for your remaining life.